Subject: Payday Loan Regulations: A Horse Race Between Red Tape and Innovation
Evaluated By: Brian Dijkema
Ontario’s new payday lending rules kicked in this year. They’re supposed to strengthen the hand of consumers who borrow less than $1500 for terms of less than 60 days. But will the rules succeed?
Cardus graded the new regulations according to research drawn from our report “Banking on the Margins: Finding Ways to Build an Enabling Small-Dollar Credit Market”. Here are the results:
Interest Rate Caps:
In 2015, Ontario’s rate cap was $21 per $100 borrowed. It’s dropped to $15 per $100 on January 1. Reduced rates are the activists’ darling, but research shows that if you need to borrow $300 for ten days to buy necessities and pay bills, its effect is limited or negative. The difference leaves a bit of extra money in peoples’ pockets but not nearly enough to fix the cash flow problem that led to the loan. Under the old rate, if you borrowed $500, you would have to pay back $605 at the end of 10 days. Under the new rate, you will have to pay back $575. The difference of $30 is nothing to sneeze at, but the customer didn’t take out a loan because they were $30.00 short. They took out a loan because they were $500 short. And the marginal difference between paying back $605 and $575 is not wide enough to significantly alter consumers’ behaviour or reduce demand.
It is likely, however, to have a significant impact on the availability of credit. Our data show the new rates are likely to drive many lenders out of business or underground. As we showed using financial data from payday loan companies, the interest rate change will have a significant negative effect on the solvency of the most dominant providers in the market. A study conducted by the government in 2009 showed that the cost of provision of these loans was equal to or higher than what the government will allow lenders to charge. This means that the supply of loans is likely to dry up, leaving consumers dependent on more expensive options, or lead to the growth of illegal loan-sharking. Even if some lenders adapt, which is entirely possible, it is a risk, and the new cap is likely to mean less choice for consumers.